- This topic has 7 replies, 4 voices, and was last updated 5 years ago by
.
- Posts
Hi Dear Tutor, I have a question.
Q 42. VV Company has been asked to quote for a special contract. The contract requires 100 hrs of labour. However, the labourers who are each paid $15 per hour, are working at full capacity.
There is a shortage of labour in the market. The labour required to undertake this special contract would have to be taken from another contract,Z, which currently utilises 500 hours of labour and generates $5000 worht of contributions.
If the labour was taken from contract Z, then the whole of contract Z would have to be delayed, ans such delay would invoke a penalty fee of $1000.
What is the relevant cost of the labour for special contract?why we take direct labor cost 100*15 as relevant cost?it will be paid anyway no matter of labourer will have idle time or working at full capacity.
As I explain in my free lectures, if a limited resource is taken for a new contract then the relevant cost is the lost contribution from whatever the resource is currently being used for plus the cost of the resource used.
Consider this:
Suppose they currently make a product that has a selling price of $20, a labour cost of $5 and other variable costs (e.g. materials) of $8. So the contribution is $7.If the labour is taken for a new contract, then we lose the revenue of $20 but we no longer need the materials etc of $8 (we will still be paying for the labour so no saving there).
So the net amount lost (and therefore the relevant cost) is 20 – 8 = $12. This is always the same as the lost contribution ($7) plus the cost of the labour ($5).
No, because in this specific question taking the labour will not mean losing contract Z but will just mean delaying contract Z.
So we will still be getting the contribution from Z, but we will have to pay for more labour (because they will be working on Z and on the special contract) and we will have to pay the penalty because Z will be delayed.
So the relevant cost is (100 x $15) + 1,000.
Dear sir, there is 1 question in Study text with answers that relevant cost for labour = labor cost + variable overhead+ lost contribution .It excludes direct material cost.Please help me to explain in which case relevant cost of labour includes and excludes of direct material cost. Thank you.
Look at my first reply above.
If it is labour that it in short supply then the relevant cost is the lost contribution plus the cost of the labour. If variable overheads are on a hourly basis then it includes them as well.
Materials are irrelevant as I explain in my first reply.
- The topic ‘Relevant cost’ is closed to new replies.